Takeaway: We added Wayfair to Investing Ideas on the short side on 6/5.

Stock Report: Wayfair (W) - HE W table 06 12 19

THE HEDGEYE EDGE

Wayfair (W) is facing increasing competition from the likes of WMT, Ikea, AMZN, & TGT while macro headwinds will make it increasingly difficult for the industry to grow at even half its historical rate at the same time W’s top-line comps get tougher. We expect the growth profile at this company will slow materially as this year progresses.

VERY GOOD COMPANY, BUT TERRIBLE BUSINESS MODEL
Wayfair is great at what it does, but what it does will never accrue to making money or creating value for shareholders. Management seems to have spent so much time building an empire because it could, but did not appropriately consider whether it should. The gross margin structure of this company is broken, and it lacks the leverage to manage SG&A to a level that will result in positive margins without egregiously curtailing top line growth. Our research shows that brick & mortar is critical in this business, and W will have to build or acquire it to stave off intensifying competition in the US. Overseas growth is self-destructive on margins. 

CONSENSUS LOOKING RIGHT THROUGH COMPETITIVE FORCES
Our discussions with key vendors suggest that AMZN is cutting prices with a clear bulls-eye on Wayfair, while simultaneously building alliances with furniture brands. At the same time we’re seeing W’s success attract competition from players that have on-line capabilities on top of brick & mortar dominance. Walmart’s new furniture line is a risk, Ikea creating an online furniture marketplace is a dark horse disruptor, and #oldretail laggards like Target, Bed Bath & Beyond and Pier 1 are getting flat-out desperate. As competition intensifies, we’re seeing Street estimates for W incremental share gain ACCELERATE by 800bps to new historical peak. #no

THE ‘AMZN OF FURNITURE’ BULL THESIS IS FLAT-OUT FLAWED
Comparison between W and AMZN is staggering – as W is being valued identically to AMZN at a similar point in its lifecycle (3/05). The difference is that AMZN actually turned a profit then, and does now. That won’t happen for W. You gotta believe that W can generate a 4.8% net margin on the midpoint of management’s bullish long-term TAM guide in order to justify where the stock is today.

For an added kicker, we’ll respectfully go against Wayfair CEO Niraj Shah’s comment on the call that “Macro doesn’t really matter” – it does, and will, particularly for a company with an unsustainably low gross margin structure to fund the SG&A costs inherent in growing the business.

As we move from US Macro Quad 3 into Quad 4 (both real growth slowing), at the same time compares get difficult AND we see both the competitive landscape heat up for W in its core US market from REAL competitors (this goes beyond the AMZN call), and the company self-destructs as it scales up its European business – which is a flat-out strategic mistake.

A slowing topline is a big risk for a stock with no earnings trading at 2.2x trailing sales. We think growth will slow from low 40s to the mid 20s, or worse, by year-end with no improvement in profitability. It’s happened before -- note 2016 when sales decelerated from 70% to 50%... we saw the EV/Sales multiple compress by half. History is likely to repeat itself as it relates to slowing growth impacting the stock.

Our view is that throughout 2019, the steepening competitive landscape on top of a slowing Macro environment will take revenue growth expectations down, capital intensity up, and lead to 40-60% downside in the stock. And yes, it needs to tap capital markets to grow.

ONE-YEAR TRAILING CHART

Stock Report: Wayfair (W) - HE W chart 06 12 19